Banks have been ordered to halt loans to investment vehicles backed by local governments as Beijing becomes increasingly worried about the ability of those governments to pay back debts. It is part of a larger effort at tightening access to credit after new loans amounted to nearly US$200 billion in January.
The investment vehicles are particularly worrisome because it is unclear exactly how much debt is involved; estimates range from US$878 billion to US$1.6 trillion. In this opacity, they are reminiscent of a practice by which domestic banks temporarily sold loans to trust companies to move debts off their balance sheets. Before the China Banking Regulatory Commission closed that loophole in January, banks were able to claim reduced exposure to the loans despite no clear indication of a real reduction in their risk.
Like other efforts at winding down its stimulus, Beijing must balance tighter control with economic growth, and it will likely prefer local governments to complete projects funded by both official and unofficial loans. However, we can expect Beijing to try to more strictly control approval of new projects.
This targeted tightening shouldn’t distract from the fact that China’s monetary environment remains very loose, with a target of US$1 trillion in new loans for the year. The preventive measure of going after local government investment vehicles is therefore unlikely to significantly impact China’s growth.